FRED if the Banks bad loans are the Fed's Assets?

[charliebrown]

Re: FRED if the Banks bad loans are the Fed's Assets?

mmm hhmm and who is going to buy that 1.5T of MBS at
anything near what the fed paid for it.

Only buy backs from freddie and fannie with treasury dept backing that's who.

[jacobdcoates]

Re: FRED if the Banks bad loans are the Fed's Assets?

actually a steady money supply means increasing bankruptcies, which will further impairs banks balance sheets, leading to very,very bad things.

[dummass]

Re: FRED if the Banks bad loans are the Fed's Assets?

mmm hhmm and who is going to buy that 1.5T of MBS at
anything near what the fed paid for it.

Only buy backs from freddie and fannie with treasury dept backing that's who.

That's strange, I just asked Ask the same question on the 401k thread.

If history can be our guide, the Fed will package the debt into large portfolios that only a few, large, financial institutions can afford to participate in. You know... the old gang. They will buy them for pennies on the dollar.

[ASH]

Re: FRED if the Banks bad loans are the Fed's Assets?

actually a steady money supply means increasing bankruptcies, which will further impairs banks balance sheets, leading to very,very bad things.

Agreed. I was thinking "steady rate of loan defaults" = "bankruptcies". However, a "steady money supply" implies that something unstated is counter-acting the deflationary impact of the loan defaults, averting bank failure.

[ASH]

Re: FRED if the Banks bad loans are the Fed's Assets?

mmm hhmm and who is going to buy that 1.5T of MBS at
anything near what the fed paid for it.

Only buy backs from freddie and fannie with treasury dept backing that's who.

This is what I'm thinking:

A lot depends upon what happens in the coming year(s). Despite all this talk from the Fed of winding down their extraordinary monetary stimulus measures, I suspect that they will be unable to withdraw their support without tanking the recovery. That being the case, it might be quite some time before they do a lot of selling. I think the default rate on various loans will need to come down substantially before the Fed unwinds, and that this won't happen anytime soon.

If a long time passes between purchase and attempted sale, then I assume that the market value of the assets purchased by the Fed will fall below the price paid to the banks. As I mentioned elsewhere on this thread, this creates a potential problem when lending eventually picks up, and the Fed wants to drain reserves from the banking system. This isn't as big a problem as it appears, because there are other ways to control the money supply. For instance, adjustment of reserve fraction requirements would accomplish the same thing. The point to remember is that this is all funny money -- it's a matter of rules, and you may have noticed that the rules change when the going gets tough. (Remember how the deflationists said the Fed would never take bad assets onto its balance sheet?) Withdrawing reserves from the system (or otherwise controlling money growth from domestic causes) when lending picks up is no more fundamental a problem than supplying reserves to the system to prevent a deflationary spiral was. It's not a question of the Fed painting itself into a corner; where funny fiat money is concerned, you can do all sorts of things. The real question is will you. The dangers we face are that (a) the government wants/needs some significant inflation so may not choose to withdraw liquidity, (b) the government's chosen response to a crisis caused by too much debt is to create even more debt, (c) our control over fiat funny money largely stops at our borders, so we are vulnerable to a currency crisis for foreign exchange that we can't 'magic' away (inflation by other means), and (d) the government -- especially a populist future government -- may be tempted to monetize its deficit, giving us the hyperinflationary feedback loop that JT fears. (Big picture, I have always believed that our government's over-commitment can only end in high inflation in the future.)

[BillBoard]

Re: FRED if the Banks bad loans are the Fed's Assets?

Hey ASH, thank you for the excellent replies.

I have been concentrating in separating the true mechanical process of the money system, from those that are subject to political decisions.

To illustrate my point, take the interest rate, that being a political decision, but once the rate of interest is set, the decay of the money supply is purely a mechanical process.

I have learned much from iTulip and think I have a clear understanding of how the system works, now I want to understand at what point the current system may become unbearable for the masses, and I think we can much quantify that variable and called it something like Rule 34.

I have found that a laborers fixed cost of housing, the minimum wage rate, prime rate, federal funds rate, petroleum price and other variables tend to set the "redeeming" cost of a currency unit in labor time.

That is to say that if a laborer had to work X hours for Y dollars, now that laborer is working X more hours for less Y dollars. But that statement is not really valid to express it in dollars, because what in effect may have happened is that the laborer's quality of life may have decreased.

For example, before he may have lived in his own apartment paying $500 a month, now he may still pay $500 a month but can only afford an apartment with a room mate that pays another $500. Same money supply and rate, higher cost of housing, lower standard of living.

[ASH]

Re: FRED if the Banks bad loans are the Fed's Assets?

Ok. We're on the same page ASH. You're just obviously a lot smarter than I am. Thanks for your comments, I have enjoyed reading.

Thanks, LSA, but you do me too much honor. Not smarter... probably just more long-winded.

I think I've got a handle on this stuff, but then again, it's not like I've made wonderful investment decisions over the past year. I think the test of knowledge is application, and right now, all that thinking about the mechanics of banking isn't making me rich.

Anyway, I enjoy reading your comments too; lets keep the iTulip conversation going.

[lsa420]

Re: FRED if the Banks bad loans are the Fed's Assets?

Agreed. I was thinking "steady rate of loan defaults" = "bankruptcies". However, a "steady money supply" implies that something unstated is counter-acting the deflationary impact of the loan defaults, averting bank failure.

ASH - glad you're enjoying the discussion as well. I have a couple of questions for you and jacob.

1. Which money supply are we talking about?

2. The money supply growth required to avert bankruptcies - where/who is the source of the growth? Is this mostly a fractional reserve phenomena or is it the Fed?

Latest data (NSA):

[jacobdcoates]

Re: FRED if the Banks bad loans are the Fed's Assets?

ASH - glad you're enjoying the discussion as well. I have a couple of questions for you and jacob.

1. Which money supply are we talking about?

2. The money supply growth required to avert bankruptcies - where/who is the source of the growth? Is this mostly a fractional reserve phenomena or is it the Fed?

Latest data (NSA):

The answer to question 1 IMHO would be MZM. I think it most accurately captures the stock of spendable money available.

The answer to question 2 is a little more difficult. The FED and UST are currently counterbalancing the deflationary effects of defaulted loans, sort of. The Fed's "liquidity" is currently parked in the excess reserves(the reason why the 1st half of the banks haven't failed) and MBS. This explains two things, currently. One is that the nominal prices of housing has for the time being stopped falling like a rock and stabilized somewhat and why the general price level hasn't sky rocketed and 2nd half the banks haven't failed. The money is currently only going to Housing. But the money that they are creating which shows up in the MZM is not making to main street(except for Housing), which is why we have a sort of slow grinding down of main street. The UST is currently supports the general consumption level by deficit spending which is why the general price level hasn't fallen either.

It is an unstable steady state that they are holding the economy in. The current state is entirely dependent on how much the UST can borrower without rates rising more that a couple of points and how much the FED can debase the currency without causing a run on the dollar. It appears the the UST has started to reach its' limit and the FED's time maybe approaching sooner than most think.

The artifact that you speak of is due the fractional reserve system and capital requirements. There is a great discussion on the topic between ASH and Jtabeb on another thread that I recommend reading. But the essential part that must be understood is that interest is due on every outstanding loan and that interest must be paid out of new loans and their daughter loans in the fractional reserve banking system. No increasing loan level means no new money to pay the interest due and hence somewhere, somehow a borrower can't pay his loan and will declare bankruptcy.

P.S.-We are broke because of the nature of compounding interest, not necessarily due to the amount that we have borrowed. Proflagrancy was not our sin, stupidity was.

[Jay]

Re: FRED if the Banks bad loans are the Fed's Assets?

The artifact that you speak of is due the fractional reserve system and capital requirements. There is a great discussion on the topic between ASH and Jtabeb on another thread that I recommend reading. But the essential part that must be understood is that interest is due on every outstanding loan and that interest must be paid out of new loans and their daughter loans in the fractional reserve banking system. No increasing loan level means no new money to pay the interest due and hence somewhere, somehow a borrower can't pay his loan and will declare bankruptcy.

This isn't true. It only means that the banks end up with all the money in the end. The interest payments go to the banks, they don't disappear. The bankers and their backers can use those payments to buy whatever they want, injecting the money back into the economy. The real issue is whether the velocity of money goes down because a few very wealthy bankers don't spend like the American consumer.

One other issue, on a broader socioeconomic level, is that interest and the subsequent capital hoarding that the process engenders, creates the wealth gap.

[ASH]

Re: FRED if the Banks bad loans are the Fed's Assets?

This isn't true. It only means that the banks end up with all the money in the end. The interest payments go to the banks, they don't disappear. The bankers and their backers can use those payments to buy whatever they want, injecting the money back into the economy. The real issue is whether the velocity of money goes down because a few very wealthy bankers don't spend like the American consumer.

I agree that the interest payments to the banks are profits which remain in the system, but I think Jacob is talking about whether there is enough money circulating in the system to make those interest payments to begin with.

There is this simplified argument that issuance of a loan creates an amount of money equal to the principal, but creates an amount of debt equal to the principal plus interest. If you paid off the principal before the interest, you would remove the money created by issuing the loan from circulation, and there would still be the need to pay the bank its interest. If all the money in the system is created by issuing credit, then there is a steadily increasing mismatch between the amount of money in circulation and the amount of interest payments which must be made. Keeping enough money circulating in the system to service older debts is one of the main reasons cited for why a steadily increasing money supply is required.

As Sharky first pointed out to me (but which should probably be obvious to anyone who has ever paid a bill on a loan), borrowers make both principal and interest payments on loans, and it isn't actually the case that borrowers pay off the principal first. Accordingly, the money created by issuing a loan can be recycled between borrower and bank multiple times before it leaves the system (as the loan principal is paid off). This alleviates the mathematical problem, because the borrower can pay off the interest on the loan using money associated with the loan principal, before that money leaves the system.

However, for this to work without creating a shortage of money with which to pay interest, it must be possible for a borrower to earn back from the bank 100% of the interest payments they owe, before the loan principal is paid off. Practically, that doesn't happen. In fact, the bank is more likely to use the profits from interest to fund additional lending, rather than buying goods or labor (even indirectly) from the borrower. So, I think in reality, there does end up being a mismatch between the supply of money and the interest due, which compounds over time.

Does that sound right to you? If the bankers spent the interest payments in a way that the borrowers could earn, there's no quantity of money problem -- but if bankers re-loan the money, there is a "remainder" problem baked into the cake?

[ASH]

Re: FRED if the Banks bad loans are the Fed's Assets?

ASH - glad you're enjoying the discussion as well. I have a couple of questions for you and jacob.

1. Which money supply are we talking about?

2. The money supply growth required to avert bankruptcies - where/who is the source of the growth? Is this mostly a fractional reserve phenomena or is it the Fed?

I agree with Jacob's responses. I think MZM is probably the closest to (1), but I admit a certain imprecision here in my thinking and writing. I am working with this concept of "the money supply", but the actual supply has many different components, and they are weighted by different velocities. I think MZM is appropriate in the context of liquid money which can be accessed quickly to pay bills or settle accounts. Also, as regards (2), I think that the Fed is primarily responsible for averting bankruptcy of banking institutions, but the Treasury is responsible for averting bankruptcy of individuals through fiscal spending measures. I haven't thought too hard about this, but my impression is that the Treasury isn't really adding to the total money supply so much as redistributing the existing stock.

[Sharky]

Re: FRED if the Banks bad loans are the Fed's Assets?

However, for this to work without creating a shortage of money with which to pay interest, it must be possible for a borrower to earn back from the bank 100% of the interest payments they owe, before the loan principal is paid off. Practically, that doesn't happen. In fact, the bank is more likely to use the profits from interest to fund additional lending, rather than buying goods or labor (even indirectly) from the borrower. So, I think in reality, there does end up being a mismatch between the supply of money and the interest due, which compounds over time.

Banks would have to pay out 100% of the interest owed, but only in aggregate, not all at once.

For example, imagine an interest-only $1000 loan at 10% interest. Let's say the borrower pays the bank $10 in interest per payment. The bank could then spend that $10 back into the economy, where it could end up back with the borrower again, and they could pay the next $10 payment. The whole process could then repeat 10 times, until the full $100 in interest is paid; the borrower would still have the original principle, which could then be repaid in full.

In that scenario, the bank only pays out 10% of the interest due at any one time, but the sum of those payments eventually equals the total interest due.

To apply this to a live bank, think about what banks do with the money they earn: it goes to pay salaries, capital equipment, etc. Much of what's left is distributed to shareholders as dividends, and those shareholders can then spend it into the economy. The bank holds onto relatively little of their total intake. What they do hold onto becomes bank capital, rather than reserves.

[jacobdcoates]

Re: FRED if the Banks bad loans are the Fed's Assets?

ASH,

You got it exactly. The only way that there is not a mismatch is if the "bank" spent every dime it made in interest profit in the economy at large on services the 'borrowers" could provide. Which would mean no bonuses, increased capital, dividends, corporate savings,...etc,etc. It would have to be a non-profit enterprise. Which will not ever happen in a profit seek financial entity. Hence there will always be a compounding mismatch at the rate of the average interest rate on outstanding loans in the system.

The interest on a loan is due first and foremost, The bank will NOT let you pay principle if there is outstanding interest and/or fees due. I work at a bank, trust me. You don't think we would let you win do you? Although there are couple of things you can do to reducing the pound of flesh the bank takes and drastically reduce your marginal effective interest rate on your loan. Some are more time consuming than others.

Ash actually is is worse..." ....If the bankers spent the interest payments in a way that the borrowers could earn, there's no quantity of money problem -- but if bankers re-loan the money, there is a "remainder" problem baked into the cake?"
If the banker re-loans the money; It compounds twice, once at the rate of the original interest amount(logarithmically declining as it is paid)plus the rate of interest on the principle of the new loan. Till a new loan is made to pay off the interest on the the loan that had to be taken out the pay the interest on the original loan. Infinite exponential expansion of said bank credit, The currency will give out first , so it is not exactly infinite, but that is a flaw of where mathematics and the real world intersect.

If you look at the Feds charts for regular bank reserves you will see that they were pretty much pegged at 40 billion for decades, even though there was a massive increases in lending from said banks. How did they do this, one might ask? The lent out the interest(and increased the rate) that they received from there current loan book, leveraging their current loan book for more loans and interest, so they could lend even more. But then they hit the 20% debt service limit and thing started to come unglued shortly there after.

But overall we got into this mess so fast by removing usury law. If you have a fractional reserve banking system with compounding interest, then bankruptcy is eventually assured. The only thing that affects the time frame of the bankruptcy is the rate of interest charged on loans. The lower the interest rate the longer the time frame to a final crackup and vise versa.

[Jay]

Re: FRED if the Banks bad loans are the Fed's Assets?

Banks would have to pay out 100% of the interest owed, but only in aggregate, not all at once.

For example, imagine an interest-only $1000 loan at 10% interest. Let's say the borrower pays the bank $10 in interest per payment. The bank could then spend that $10 back into the economy, where it could end up back with the borrower again, and they could pay the next $10 payment. The whole process could then repeat 10 times, until the full $100 in interest is paid; the borrower would still have the original principle, which could then be repaid in full.

In that scenario, the bank only pays out 10% of the interest due at any one time, but the sum of those payments eventually equals the total interest due.

To apply this to a live bank, think about what banks do with the money they earn: it goes to pay salaries, capital equipment, etc. Much of what's left is distributed to shareholders as dividends, and those shareholders can then spend it into the economy. The bank holds onto relatively little of their total intake. What they do hold onto becomes bank capital, rather than reserves.

The banks essentially end up with $100 worth of the debtors future labor. Banking is good work if you can get it, especially when it is backed by Uncle Sam!